Going Private: Legal and Strategic Considerations Structuring - - PowerPoint PPT Presentation

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Going Private: Legal and Strategic Considerations

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Structuring Transactions to Withstand Court and SEC Scrutiny

A Live 90-Minute Teleconference/Webinar with Interactive Q&A

Today's panel features: James D. Honaker, Partner, Morris Nichols Arsht & Tunnell, Wilmington, Del. Darrel A. Rice, Partner, Haynes & Boone, Dallas Nancy L. Sanborn, Partner, Davis Polk & Wardwell, New York

Tuesday, August 17, 2010 The conference begins at: The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 am Pacific 10 am Pacific

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Going Private: Legal and Strategic Considerations

Structuring Transactions to Withstand Court and SEC Scrutiny August 17, 2010

James D. Honaker, Partner Darrel A. Rice, Partner Nancy L. Sanborn, Partner Morris, Nichols, Arsht Haynes and Boone, LLP Davis Polk & Wardwell LLP & Tunnell LLP

Introduction - What is a Going Private Transaction?

What is a Going Private Transaction?

• A transaction or series of transactions:
• with a controlling stockholder, management, or other persons affiliated with a public

company

• that reduces the number of stockholders, allowing the company to terminate its

public company status and related reporting obligations under the ’34 Act Most common types of going private transactions:

• Acquisition by controlling stockholder (sometimes referred to as a squeeze-out merger)
• Acquisition by a significant but non-controlling stockholder
• Leveraged buyouts by a private equity fund or other third-party acquirer working with

management

5

Introduction - Current Trends

Going private transactions are becoming more common after a slow year in 2009

• Factors:
• Increased availability of debt financing (for both financial and strategic buyers)
• Cash positions on many corporate balance sheets
• Private equity commitments must be invested before commitment periods expire
• Growing disclosure obligations and enhanced scrutiny and regulation of public

companies

• Significant concerns remain that transactions won’t close
• Continued focus on reverse break-up fees to compensate target company if acquiror

fails to close

• Amount and circumstances when reverse break-up fee is payable
• Focus on rights to specific performance to force sources of committed debt and

equity financing to fund their commitments

6

Introduction – Focus of this Webcast

Legal and strategic considerations for going private transactions based on:

• Reasons for going private
• Structure of going private transactions
• Risk of litigation
• Delaware law developments
• Disclosure obligations under state law
• Disclosure obligations under SEC Rule 13e-3
• Section 13(d) disclosure obligations

7

Reasons for Going Private

“Going private” allows the company to avoid the disadvantages of being a public hil itti th t lli t kh ld t t i t company, while permitting the controlling stockholder to retain, or new owners to acquire, control Reasons for going private may include:

• Belief that the company’s stock is undervalued
• Allow the company to focus on long-term objectives rather than short-term profits
• Permit a more leveraged capital structure than what would be tolerable for a public

company

• Save costs and burden of compliance with the Exchange Act and the Sarbanes-Oxley

Act

• Reduce distraction of public stockholders and analysts
• Lessen risk of stockholder litigation

8

Structure of Going Private Transactions

Most common structures:

• One-step merger
• Tender offer followed by a back-end merger (also known as a two-step merger)

May be advantages to pursue a tender offer/two-step merger: May be advantages to pursue a tender offer/two step merger:

• Timing advantage - less time for SEC review (and competing bidders)
• May benefit from lesser standard of review, but Delaware law in flux

9

Risk of Litigation

Most going private transactions are challenged in court

• Typical claims:
• Breach of fiduciary duties
• Failure to comply with disclosure obligations
• Potential for conflicts of interest may lead court to apply “entire fairness” standard of

review

• Controlling stockholder conflicts
• Management conflicts
• Use of proper procedures is critical
• If entire fairness review, proper procedures may shift burden to plaintiff
• Proper procedures may allow for business judgment review rather than entire

fairness

10

Recent Developments in Delaware Law on Squeeze Out Transactions Squeeze-Out Transactions

Delaware case law before recent decision in CNX :

• According to Delaware Supreme Court (Kahn v. Lynch): one-step merger with

controlling stockholder reviewed for entire fairness, but burden shifted to plaintiffs to prove “not fair” if transaction approved by either:

• Special committee of independent disinterested directors or
• Special committee of independent, disinterested directors or
• Majority of the minority stockholders
• According to Chancery Courts (e.g., Pure Resources): two-step merger with controlling

stockholder subject to more deferential business judgment review if transaction “non- stockholder subject to more deferential business judgment review if transaction non- coercive”:

• Same consideration in both steps;
• Non-waivable majority of the minority tender condition;

Non waivable majority of the minority tender condition;

• Promise to consummate short-form merger if controller obtains 90% stock ownership

in tender offer; and

• Special committee of independent, disinterested directors provided sufficient time

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Spec a co ee o depe de , d s e es ed d ec o s p o ded su c e e and information to make a recommendation to minority.

Recent Developments in Delaware Law on Squeeze Out Transactions (

t )

Squeeze-Out Transactions (cont.)

Chancery Court decision in CNX shifted this landscape: Facts in CNX: Facts in CNX:

• 80% stockholder launched a two-step tender offer to acquire the minority interest of CNX Gas.
• Controlling stockholder followed Pure Resources model:
• No negotiations with special committee (tender offer price was result of bargaining with
• No negotiations with special committee (tender offer price was result of bargaining with

significant minority stockholder, which also owned stock in controller)

• Special committee formed after launch of tender offer – did not express opinion on

whether stockholders should tender; noted concerns about the process resulting in the

• ffer price

CNX Holding:

• Satisfying Pure Resources test is not sufficient to attain business judgment review
• Business judgment review is available only if transaction is both:
• Approved by special committee vested with full power of board to respond to offer, and
• Approved by a majority of the minority stockholders

12

Recent Developments in Delaware Law on Squeeze Out Transactions (

t )

Squeeze-Out Transactions (cont.)

Implications of CNX for Two-Step Tender Offers:

• Business judgment review appropriate only when transaction approximates true arms-

length process

• Must balance following CNX structure with disadvantages of powerful special

committee committee

• CNX raises the bar for potential damages claims if the controlling stockholder

commences a two-step tender offer without complying with CNX requirements

• Transaction would be reviewed for entire fairness

Transaction would be reviewed for entire fairness

• Settlement value for claims challenging a non-CNX-compliant transaction has

increased

13

Recent Developments in Delaware Law on Squeeze Out Transactions (cont ) Squeeze-Out Transactions (cont.)

Other Implications for Two-Step Tender Offers:

• Special Committee Authority: To obtain business judgment review, CNX suggests

special committee should have full power of board, including power to:

• Explore alternative transactions (or decide not to)
• Adopt poison pill
• Negotiate terms of the transaction
• Calculating Majority-of-the-Minority Stockholder Approval. True majority of unaffiliated

t kh ld i i d stockholders is required.

• CNX suggests a “hedged stockholder” (a minority stockholder who owned a similar

economic interest in both the controlling stockholder and the target company) should have been excluded from calculation have been excluded from calculation

• Directors, officers and employees should likely be excluded
• “Denominator” should include all (and only) minority shares

14

Recent Developments in Delaware Law on Squeeze- Out Transactions (

t )

Out Transactions (cont.)

• Expect judicial skepticism of directors who do not stand up to controlling stockholders:
• Landry’s: Court of Chancery highly critical of
• target board’s failure to adopt a poison pill to prevent the CEO from creeping to a

control position through open market purchases, and

• board’s decision to waive payment of reverse break fee when CEO terminated

merger agreement

• Loral: Court of Chancery found breach of fiduciary duty when company issued

additional equity to 35% stockholder in a PIPE transaction additional equity to 35% stockholder in a PIPE transaction

• No pressing need for equity
• Directors did not explore other alternatives for raising equity

15

Recent Developments in Delaware Law on Squeeze Out Transactions (

t )

Squeeze-Out Transactions (cont.)

Impact of CNX on One-Step Mergers with Controlling Stockholders:

• Vice Chancellor Laster (like Vice Chancellor Strine in Cox Communications) advocates

“unified approach”

• Business judgment review should apply to one-step squeeze-out mergers (like two-

step transactions) if both: step transactions) if both:

• Negotiated and approved by a special committee of independent, disinterested

directors, and

• Conditioned on affirmative vote of a majority-of-the-minority stockholders
• Conditioned on affirmative vote of a majority-of-the-minority stockholders.
• Supreme Court precedent (Kahn v. Lynch) still stands:
• Entire fairness review applies, but burden shifted to plaintiffs to prove “not fair” if

transaction approved by either: transaction approved by either:

• Special committee of independent, disinterested directors or
• Majority-of-the-minority stockholders

16

Recent Developments in Delaware Law on Management/Private Equity Buyouts Management/Private Equity Buyouts

In general, entire fairness standard does not apply if controlling stockholder is not i l d i i i t t ti involved in going private transaction

• Involves sale of the company so Revlon applies: directors responsible for obtaining the

highest value reasonably attainable for the shareholders

• If a target is thoroughly shopped pre signing it is more reasonable for the target to
• If a target is thoroughly shopped pre-signing, it is more reasonable for the target to

enter into “tighter” deal protection to encourage the buyer to put its last nickel on the table

• If there are reasons not to conduct broad pre-signing auction:

p g g

• may be possible to rely on a post-signing market check to satisfy Revlon
• looser deal protection: “go shop” period; weak “window shops”; smaller

termination fees.

17

Recent Developments in Delaware Law on Management/Private Equity Buyouts (

t )

Management/Private Equity Buyouts (cont.)

Involvement/participation by management may create conflicts of interests, giving i t i k d l ill b j i d t ti l t d l l it f d i t rise to risk deal will be enjoined or potential post-deal lawsuit for damages against directors

• Delaware’s Court of Chancery has summarized two of these concerns:
• “Steering ” i e

concern that if management leads the sale process it will be skewed

• Steering, i.e., concern that if management leads the sale process, it will be skewed

in favor of private equity buyers or other buyers predisposed to team with management

• “Skimming,” i.e., concern that management will bargain for its own consideration (in

g, , g g ( terms of equity, future compensation or otherwise), which may reduce consideration

• ffered to non-management stockholders

18

Disclosure Obligations – Delaware Law

Delaware litigation/case law is playing significant role in establishing disclosure requirements

• Wh

t kh ld k d t t d id h th t i i l i ht “ ll

• When stockholders are asked to vote on a merger or decide whether to exercise appraisal rights, “all

material facts” must be disclosed to stockholders

• Financial projections may be material (and thus required to be disclosed), particularly if used by

the target company’s financial advisor to conduct a DCF analysis

• Netsmart: disclosure should contain (i) analyses the bankers used, (ii) the “key inputs” into

those analyses and (iii) “range of ultimate values” that were the output of those analyses.

• Other cases: undisclosed projections would not alter the “total mix” of available information or

were not sufficiently reliable to disclose. See Checkfree, 3Com (Chancellor Chandler), Globis y , ( ), (Vice Chancellor Parsons), Margolis (Vice Chancellor Noble).

• Controlling stockholder effecting second-step merger cannot necessarily rely on information

previously disclosed in the market to satisfy its disclosure obligations

• Motorola: Court of Chancery held that notice of appraisal sent to minority stockholders must
• Motorola: Court of Chancery held that notice of appraisal sent to minority stockholders must

include summary financial information and explain how to obtain additional information

• If disclosure obligations are not satisfied, court may order quasi-appraisal as a remedy.

19

Going Private Transactions under Rule 13e-3

Rule 13e-3 three-pronged test:

• Transaction is a merger, tender offer, purchase of stock, sale of all or substantially all

assets, reverse stock split, etc.;

• Issuer or an “affiliate” of the issuer is “engaged in” the transaction; and
• Reasonable likelihood or purpose of causing:
• any registered class of equity securities to be eligible for termination of registration;
• any registered class of equity securities to be eligible for termination or suspension of

ti bli ti reporting obligations; or

• any listed class of equity securities to cease to be listed.

20

Interesting (Often Challenging) Issues Under Rule 13e 3 13e-3

What is an “affiliate” of the issuer?

• Same as “affiliates” under other provisions of ’33 Act or ’34 Act: person “that controls, is

controlled by or is under common control with” the issuer (directly or indirectly).

• No bright line test establishing ownership percentage that triggers affiliation.

When is senior management (who are affiliates) “engaged” in the transaction?

• Involvement in negotiation process
• Post-closing stock ownership and role with target company, acquiror and its affiliates
• Material increases in compensation/other employment arrangements
• Receipt of other benefits not received by other stockholders
• SEC C&DI: no formal arrangement between acquiror and management is required; a

“general understanding” suffices to find engagement.

21

Interesting (Often Challenging) Issues Under Rule 13e 3 (

t )

13e-3 (cont.)

To avoid triggering Rule 13e-3, board should instruct management and acquiror not t i di i f t l i l t t th to engage in any discussions of post-closing employment agreements or other management arrangements

• Any discussions between the acquiror and management should be supervised to ensure

compliance compliance May not be possible to avoid triggering Rule 13e-3 if acquiror requires management participation

• Rollover of equity, employment agreements or other assurances that management will

continue in their roles post-closing may be critical to the acquiror’s interest in proceeding with the transaction

22

Implications of Triggering Rule 13e-3

Rule 13e-3 is a disclosure rule

• Must file Schedule 13E-3 and include additional disclosure in proxy statement
• Disclosure must be made by each filing person (target company and each affiliate

engaged in the transaction, which may include the acquiror)

• Timing implications – closer scrutiny by SEC to ensure compliance with Rule 13e-3’s

disclosure requirements. Key incremental information requirements

• P

f d t ti

• Purposes for proposed transaction
• Substantive and procedural fairness to unaffiliated stockholders
• All “reports, opinions and appraisals” received from any outside party that are “materially

related” to the transaction related” to the transaction

• Must be summarized and attached as exhibits

23

Section 13(d) Disclosure Obligations

Filing obligations include:

• Must file Schedule 13D within 10 days after acquire “beneficial ownership” of >5%

Must file Schedule 13D within 10 days after acquire beneficial ownership of >5%

• Must amend Schedule 13G within 10 days after form intent to change or influence control
• Must “promptly” amend Schedule 13D if material change

F ti f “ ” t i fili bli ti Formation of “group” may trigger filing obligation Item 4 of Schedule 13D requires disclosure of “plans or proposals” relating to securities

f

• Tracinda cease-and-desist proceedings: failure to disclose plan to sell additional shares
• NAACO Industries: misleading Schedule 13D disclosure may support common law fraud

claims

• SEC C&DI: “A plan or proposal

is not deemed to exist only upon execution of a formal SEC C&DI: A plan or proposal . . . is not deemed to exist only upon execution of a formal agreement or commencement of a tender offer, solicitation or similar transaction. Generic disclosure reserving the right to engage in any of the kinds of transactions enumerated in Item 4(a) – (j) must be amended when the security holder has formulated a specific intention with respect to a disclosable matter ” (citing Tracinda)

24

respect to a disclosable matter. (citing Tracinda)